Thursday, October 13, 2011

Ichimoku Strategy

ICHIMOKU STRATEGY

Description

Ichimoku Kinko Hyo is an indicator designed for trend trading charting system that has been successfully used in nearly every tradeable market. It is unique in many ways, but its primary strength is its use of multiple data points to give the trader a deeper, more comprehensive view into price action, support/resistance levels, trend direction, and entry/exit points.
General theory behind this indicator states that if price action is above the cloud, the overall trend is bullish, and if below the cloud, the overall trend is bearish. There are also moving averages (the Tenkan and Kijun lines) which act like the MACD crossover signals with the Tenkan crossing from underneath the Kijun as a bullish signal, while crossing overhead giving a bearish signal.
This deeper view, and the fact that Ichimoku is a very visual system, enables the trader to quickly discern and filter "at a glance" the low-probability trading setups from those of higher probability.

History

The charting system of Ichimoku Kinko Hyo was developed by a Japanese newspaper man named Goichi Hosoda. He spent thirty years perfecting the technique before releasing his findings to the general public in 1968. Ichimoku Kinko Hyo has been used extensively in Asian trading rooms since Hosoda published his book and has been used successfully to trade currencies, commodities, futures, and stocks. Even with such wild popularity in Asia, Ichimoku did not make its appearance in the West until the 1990s and then, due to the utter lack of information in English on how to use it, it was mostly relegated to the category of another "exotic" indicator by the general trading public.

Ichimoku Components

Tenkan-Sen
It is primarily used as a signal line and a minor support/resistance line.
It measures the average of price's highest high and lowest low for the last 9 periods. Hosoda believed that using the average of price extremes over a given period of time was a better measure of equilibrium than merely using an average of the closing price.

Kijun-Sen
This is a confirmation line, a support/resistance line, and can be used as a trailing stop line.
It measures the average of price's highest high and lowest low, though it does so over a longer time frame of 26 periods as opposed to the Tenkan Sen's 9 periods. Due to the longer time period it measures, the Kijun Sen is a more reliable indicator of short-term price sentiment, strength and equilibrium than the Tenkan Sen. If price has been ranging, then the Kijun Sen will reflect the vertical midpoint of that range (price equilibrium) via its flat aspect. Once price exceeds either the last highest high or lowest low within the last 26 periods, however, the Kijun Sen will reflect that by either angling up or down, respectively. Thus, short-term trend can be measured by the direction of the Kijun Sen. In addition, the relative angle of the Kijun Sen will indicate the strength or momentum of the trend.

Chikou Span
Also called the lagging span it is used as a support/resistance aid. It represents one of Ichimoku's most unique features; that of time-shifting certain lines backwards or forwards in order to gain a clearer perspective of price action. In the Chikou span's case, the current closing price is time-shifted backwards by 26 periods. While the rationale behind this may at first appear confusing, it becomes very clear once we consider that it allows us to quickly see how today's price action compares to the price action of 26 periods ago, which can help determine trend direction.

Senkou Span A
The Senkou span A Also called leading span 1, this line forms one edge of the Kumo, or “Ichimoku cloud” that is the foundation of the Ichimoku Kinko Hyo charting system. The Senkou Span A is another one of the time-shifted lines that are unique to Ichimoku. In this case, it is shifted forwards by 26 periods. Since it represents the average of the Tenkan Sen and Kijun Sen, the Senkou Span A is itself a measure of equilibrium.

Senkou Span B
Also called leading span 2, this line forms the other edge of the Kumo, or "Ichimoku cloud" that is the foundation of the Ichimoku Kinko Hyo charting system. On its own, the Senkou Span B line represents the longest-term view of equilibrium in the Ichimoku Kinko Hyo system. Rather than considering only the last 26 periods in its calculation like the Senkou Span A, the Senkou Span B measures the average of the highest high and lowest low for the past 52 periods. It then takes that measure and time-shifts it forward by 26 periods, just like the Senkou Span A.

Kumo
Kumo is the space between Senkou Span A and B. The cloud edges identify current and potential future support and resistance points; perhaps the most immediately visible component of Ichimoku that immediately distinguish the prevailing "big picture" trend and price's relationship to that trend
The Kumo cloud changes in shape and height based on price changes. This height represents volatility as larger price movements form thicker clouds, which creates a stronger support and resistance. As thinner clouds offer only weak support and resistance, prices can and tend to break through such thin clouds.
Generally, markets are bullish when Senkou Span A is above Senkou Span B and vice versa when markets are bearish. Traders often look for Kumo Twists in future clouds, where Senkou Span A and B exchange positions, a signal of potential trend reversals.
In addition to thickness, the strength of the cloud can also be ascertained by its angle; upwards for bullish and downwards for bearish. Any clouds behind price are also known as Kumo Shadows.

Trading

Tenkan Sen/Kijun Sen Cross

The Tenkan Sen/ Kijun Sen cross is the one of the most traditional trading strategies within the Ichimoku Kinko Hyo system. The signal for this strategy is given when the Tenkan Sen crosses over the Kijun Sen. If the Tenkan Sen crosses above the Kijun Sen, then it is a bullish signal. Likewise, if the Tenkan Sen crosses below the Kijun Sen, then that is a bearish signal. Like all strategies within the Ichimoku system, the Tenkan Sen/Kijun Sen cross needs to be viewed in terms of the bigger Ichimoku picture before making any trading decisions, as this will give the strategy the best chances of success.

In general, the Tenkan Sen/Kijun Sen strategy can be classified into three major classifications: strong, neutral and weak.
STRONG
A strong Tenkan Sen/Kijun Sen cross Buy signal takes place when a bullish cross happens above the Kumo.
A strong Tenkan Sen/Kijun Sen cross Sell signal takes place when a bearish cross happens below the Kumo.
NEUTRAL
A neutral Tenkan Sen/Kijun Sen cross Buy signal takes place when a bullish cross happens within the Kumo.
A neutral Tenkan Sen/Kijun Sen cross Sell signal takes place when a bearish cross happens within the Kumo.
WEAK
A weak Tenkan Sen/Kijun Sen cross Buy signal takes place when a bullish cross happens below the Kumo.
A weak Tenkan Sen/Kijun Sen cross Sell signal takes place when a bearish cross happens above the Kumo.

With these three major classifications in mind, we will add something else into the equation - the Chikou Span. As we explained in the section detailing the Chikou Span, this component acts as a "final arbiter" of sentiment and should be consulted with every single trading signal in the Ichimiku Kinko Hyo charting system. The Tenkan Sen/Kijun Sen cross is no different. Each of the three classifications of the TS/KS cross mentioned above can be further classified based on the Chikou Span's location in relation to the price curve at the time of the cross. If the cross is a "Buy" signal and the Chikou Span is above the price curve at that point in time, this will add greater strength to that buy signal. Likewise, if the cross is a "Sell" signal and the Chikou Span is below the price curve at that point in time, this will provide additional confirmation to that signal. If the Chikou Span's location in relation to the price curve is the opposite of the TS/KS cross's sentiment, then that will weaken the signal.

Entry
The entry for the Tenkan Sen/ Kijun Sen cross is very straightforward - an order is placed in the direction of the cross once the cross has been solidified by a close. Nevertheless, in accordance with good Ichimoku trading practices, the trader should bear in mind any significant levels of support/resistance near the cross and consider getting a close above those levels before executing their order.
Exit
The exit from a Tenkan Sen/ Kijun Sen cross will vary with the particular circumstances of the chart. The most traditional exit signal is a Tenkan Sen/ Kijun Sen cross in the opposite direction of your trade. However, personal risk management and time frame concerns may dictate an earlier exit, or an exit based upon other Ichimoku signals, just as in any other trade.
Stop-Loss Placement
The Tenkan Sen/ Kijun Sen strategy does not dictate use of any particular Ichimoku structure for stop-loss placement, like some other strategies do. Instead, the trader should consider their execution time frame and their money management rules and then look for the appropriate prevailing structure for setting their stop-loss.
Take Profit Targets
Take profit targeting for the Tenkan Sen/ Kijun Sen cross strategy can be approached in one of two different ways. It can be approached from a day/swing trader perspective where take profit targets are set using key levels, or from a position trader perspective, where the trader does not set specific targets but rather waits for the current trend to be invalidated by a Tenkan Sen/ Kijun Sen cross transpiring in the opposite direction of their trade.

Kijun Sen Cross

The Kijun Sen cross is the one of the most powerful and reliable trading strategies within the Ichimoku Kinko Hyo system. It can be used on nearly all time frames with excellent results, though it will be somewhat less reliable on the lower, day trading time frames due to the increased volatility on those time frames. The Kijun Sen cross signal is given when price crosses over the Kijun Sen. If it crosses the price curve from the bottom up, then it is a bullish signal. If it crosses from the top down, then it is a bearish signal. Nevertheless, like all trading strategies within the Ichimoku Kinko Hyo system, the Kijun Sen cross signal needs to be evaluated against the larger Ichimoku "picture" before committing to any trade.

In general, the Kijun Sen cross strategy can be classified into three major classifications: strong, neutral and weak.

STRONG
A strong Kijun Sen cross Buy signal takes place when a bullish cross happens above the Kumo.
A strong Kijun Sen cross Sell signal takes place when a bearish cross happens below the Kumo.
NEUTRAL
A neutral Kijun Sen cross Buy signal takes place when a bullish cross happens within the Kumo.
A neutral Kijun Sen cross Sell signal takes place when a bearish cross happens within the Kumo.
WEAK
A weak Kijun Sen cross Buy signal takes place when a bullish cross happens below the Kumo.
A weak Kijun Sen cross Sell signal takes place when a bearish cross happens above the Kumo.

As with the Tenkan Sen/Kijun Sen cross strategy, the savvy Ichimoku trader will make good use of the Chikou Span to confirm any Kijun Sen cross signal. Each of the three classifications of the Kijun Sen cross outlined above can be further classified based on the Chikou Span's location in relation to the price curve at the time of the cross. If the cross is a "Buy" signal and the Chikou Span is above the price curve at that point in time, this will add greater strength to that buy signal. Likewise, if the cross is a "Sell" signal and the Chikou span is below the price curve at that point in time, this will provide additional confirmation to that signal. If the Chikou Span's location in relation to the price curve is the opposite of the Kijun Sen cross's sentiment, then that will weaken the signal.
Entry
The entry for the Kijun Sen cross is very straightforward - an order is placed in the direction of the cross once the cross has been solidified by a close. Nevertheless, in accordance with good Ichimoku trading practices, the trader should bear in mind any significant levels of support/resistance near the cross and consider getting a close above those levels before executing their order.
Exit
A trader exits a Kijun Sen cross trade upon their stop-loss getting triggered when price crossing the Kijun Sen in the opposite direction of their trade. Thus, it is a key that the trader moves their stop-loss in lockstep with the movement of the Kijun Sen in order to maximize their profit.
Stop-Loss Placement
The Kijun Sen cross strategy is unique among Ichimoku strategies in that the trader's stop-loss is determined and managed by the Kijun Sen itself. This is due to the Kijun Sen's strong representation of price equilibrium, which makes it an excellent determinant of sentiment. Thus, if price retraces back below the Kijun Sen after executing a bullish Kijun Sen cross, then that is a good indication that insufficient momentum is present to further the nascent bullish sentiment.
When entering a trade upon a Kijun Sen cross, the trader will review the current value of the Kijun Sen and place their stop-loss 5 to 10 pips on the opposite side of the Kijun Sen that their entry is placed on. The exact number of pips for the stop-loss "buffer" above/below the Kijun Sen will depend upon the dynamics of the pair and price's historical behavior vis-a-vis the Kijun Sen as well as the risk tolerance of the individual trader, but 5 to 10 pips should be appropriate for most situations. When looking to enter short, the trader will look to place their stop-loss just above the current Kijun Sen and when looking to enter long, the trader will place their stop-loss just below the current Kijun Sen.
Once the trade is underway, the trader should move their stop-loss up/down with the movement of the Kijun Sen, always maintaining the 5 to 10 pip "buffer". In this way, the Kijun Sen itself acts as a "trailing stop-loss" of sorts and enables the trader to keep a tight hold on risk management while maximizing profits.
Take Profit Targets
Take profit targeting for the Kijun Sen cross strategy can be approached in one of two different ways. It can be approached from a day/swing trader perspective where take profit targets are set using key levels, or from a position trader perspective, where the trader does not set specific targets but rather waits for the current trend to be invalidated by price crossing back over the Kijun Sen in the opposite direction of their trade.

Kumo Breakout

Kumo Breakout trading or "Kumo Trading" is a trading strategy that can be used on multiple time frames, though it is most widely used on the higher time frames (e.g.: Daily, Weekly, Monthly) of the position trader. Kumo breakout trading is the purest form of trend trading offered by the Ichimoku charting system, as it looks solely to the Kumo and price's relationship to it for its signals. It is "big picture" trading that focuses only on whether price is trading above or below the prevailing Kumo. In a nutshell, the signal to go long in Kumo breakout trading is when price closes above the prevailing Kumo and, likewise, the signal to go short is when price closes below the prevailing Kumo.

Entry
The entry for the Kumo breakout trading strategy is simple - when price closes above/below the Kumo, the trader places a trade in the direction of the breakout. Nevertheless, care does need to be taken to ensure the breakout is not a "head fake" which can be especially prevalent when the breakout takes place from a flat top/bottom Kumo. To ensure the flat top/bottom is not going to attract price back to the Kumo, it is always advisable to look for another Ichimoku structure to "anchor" your entry to just above/below the Kumo breakout. This anchor can be anything from a key level provided by the Chikou span, a Kumo shadow or any other appropriate structure that could act as additional support/resistance to solidify the direction and momentum of the trade.
Kumo breakout traders also make good use of the leading Kumo's sentiment before committing to a trade. If the leading Kumo is a Bear Kumo and the Kumo breakout is also Bear, then that is a very good sign that the breakout is not an aberration of excessive volatility, but rather a true indication of market sentiment. If the leading Kumo contradicts the direction of the breakout, then the trader may want to either wait until the Kumo does agree with the direction of the trade or use more conservative position sizing to account for the increased risk.
Exit
The exit from a Kumo breakout trade is the easiest part of the whole trade. The trader merely waits for their stop-loss to get triggered as price exits the opposite side of the Kumo on which the trade is transpiring. Since the trader has been steadily moving their stop-loss up with the Kumo during the entire lifespan of the trade, this assures they maximize their profit and minimize their risk.
Stop-Loss Placement
Being a "big picture" trend trading strategy, the stop-loss for the Kumo breakout strategy is placed at the point that the trend has been invalidated. Thus, the stop-loss for a Kumo breakout trade must be placed on the opposite side of the Kumo that the trade is transpiring on, 10 - 20 pips away from the Kumo boundary. If price does manage to reach the point of the stop-loss, the trader can be relatively assured that a major trend change has taken place.
Take Profit Targets
While traditional take profit targets can be used with the Kumo breakout trading strategy, it is more in-line with the long-term trend trading approach to simply move the stop-loss up/down with the Kumo as it matures. This method allows the trade to take full advantage of the trend without closing the trade until price action dictates unequivocally that the trend is over.

Senkou Span Cross

The Senkou Span cross is one of the lesser known trading strategies within the Ichimoku Kinko Hyo system. This is mostly due to the fact that the Senkou span cross tends to be more commonly used as an additional confirmation with other trading strategies rather than being used as a standalone trading strategy in its own right. However, it is nonetheless a solid trend trading strategy and can definitely be used on its own.
Given that the Senkou span cross strategy, like the Kumo breakout trading strategy, utilize the Kumo for signal generation, it is best employed on the longer time frames of the Daily chart and above. The Senkou span cross signal is given when the Senkou span A line crosses over the Senkou span B line of the Kumo. If the Senkou span A crosses the Senkou span B from the bottom up, then it is a bullish signal. If it crosses from the top down, then it is a bearish signal. Nevertheless, like all trading strategies within the Ichimoku Kinko Hyo system, the Senkou span cross signal needs to be evaluated against the larger Ichimoku "picture" before committing to any trade.
The thing to keep in mind with the Senkou span cross strategy is that the "cross" signal will take place 26 periods ahead of the price action as the Kumo is time-shifted 26 periods into the future. This relationship is obvious when one looks at the current price on a live chart, but less so when looking at historical price action. In addition, while all Ichimoku strategies should be exercised with the larger Ichimoku picture in mind, this is particularly important with the Senkou span cross. Thus, determining the overall trend on higher time frames first and then taking only Senkou span signals that align with that trend on the lower timeframes is the best implementation of the Senkou span strategy.

In general, the Senkou span cross strategy can be classified into three major classifications: strong, neutral and weak.

STRONG
A strong Senkou span cross signal takes place when the price curve is on the side of the Kumo that matches the sentiment of the
Senkou span cross.
NEUTRAL
A neutral Senkou span cross signal takes place when the price curve is inside the Kumo at the time of the Senkou span cross.
WEAK
A weak Senkou span cross signal takes place when the price curve is on the opposite side of the Kumo that matches the
sentiment of the Senkou span cross.

Entry
The entry for the Senkou span cross trading strategy is relatively simple, though, as mentioned above, entries do require even more attention to the overall trend on higher time frames before executing any trades. After determining the trend on the higher time frames, the trader looks for a fresh Senkou span cross in the same direction as the overall trend that has been solidified by a close on the execution time frame. Once they identify a suitable opportunity, they initiate a position in the direction of the Senkou span sentiment. As in all Ichimoku trading strategies, traders will be well-advised to consider the relative strength of the cross (vis-a-vis price's location relative to the Kumo) as well as the sentiment provided by the remaining Ichimoku components at the time of the cross in order to ensure the most optimum entry.
It is worth mentioning here that the strong bull (buy) signal outlined in our first chart that took place in April of 2005, while technically strong from a 1D perspective, was not aligned with the overall downtrend in-place on the Weekly and Monthly charts. Thus, traders taking this trade signal and using a Senkou span cross in the opposite direction as their exit signal would have actually lost pips. This underscores the importance of evaluating sentiment on multiple time frames and trading with the overall trend.
Exit
The exit from a Senkou span cross trade is generally signaled by a Senkou span cross in the opposite direction of the trade, though other exit signals may be taken depending upon the trader's risk tolerance and profit goals.
Stop-Loss Placement
Being a "big picture" trend trading strategy like the Kumo breakout strategy, the stop-loss for the Senkou span cross strategy is placed on the opposite side of the Kumo that the trade is transpiring on, 10 - 20 pips away from the Kumo boundary.
Take Profit Targets
While traditional take profit targets can be used with the Senkou span cross trading strategy, it is more in-line with the long-term trend trading approach to wait for a Senkou span cross to transpire in the opposite direction of the trade before closing out the position. This method allows the trade to take full advantage of the trend without closing the trade until price action dictates unequivocally that the trend is over.

Chikou Span Cross

For those that have been using the Ichimoku Kinko Hyo charting system for any length of time, utilizing the Chikou span cross strategy should be like second nature. Why? Because the Chikou span crosses is essentially the "Chikou span confirmation" that savvy Ichimoku traders utilize to confirm chart sentiment before entering any trade. This confirmation comes in the form of the Chikou span crossing through the price curve in the direction of the proposed trade. If it crosses through the price curve from the bottom up, then it is a bullish signal. If it crosses from the top down, then it is considered a bearish signal.
Thus, we already know the power of the Chikou span cross via its use as a confirmation strategy. However, when used within some simple guidelines, the Chikou span cross can be used as its own standalone trading strategy with very good success.

Like many other Ichimoku trading strategies, the Chikou span cross strategy uses price's relationship to the Kumo to categorize its signals into three major classifications: strong, neutral and weak.

STRONG
A strong Chikou span cross Buy signal takes place when a bullish cross takes place and current price is above the Kumo
A strong Chikou span cross Sell signal takes place when a bearish cross takes place and current price is below the Kumo.
NEUTRAL
A neutral Chikou span cross Buy signal takes place when a bullish cross takes place and current price is within the Kumo
A neutral Chikou span cross Sell signal takes place when a bearish cross takes place and current price is within the Kumo.
WEAK
A weak Chikou span cross Buy signal takes place when a bullish cross takes place and current price is below the Kumo
A weak Chikou span cross Sell signal takes place when a bearish cross takes place and current price is above the Kumo.

Entry
The entry for the Chikou span cross is relatively straightforward - the trader initiates a position in the direction of the Chikou span cross after taking into consideration the cross's strength and other chart signals. For the highest probability of success, the trader will also look for the Chikou span itself to be free of the Kumo as the Chikou span can often interact with the Kumo much like the price curve.
Exit
The most traditional exit for a Chikou span cross trade is generally signalled by a Chikou span cross in the opposite direction of the trade, though other exit signals may be taken depending upon the trader's risk tolerance and profit goals.
Stop-Loss Placement
The Chikou span strategy does not dictate use of any particular Ichimoku structure for stop-loss placement, like some other strategies do. Instead, the trader should consider their execution time frame and their money management rules and then look for the appropriate prevailing structure for setting their stop-loss.
Take Profit Targets
Take profit targeting for the Chikou span cross strategy can be approached in one of two different ways. It can be approached from a day/swing trader perspective where take profit targets are set using key levels, or from a position trader perspective, where the trader does not set specific targets but rather waits for the current trend to be invalidated by a Chikou span cross transpiring in the opposite direction of their trade.

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